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Southwest Airlines Co - Balance Sheet

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You have been presented with the following selected information taken from the financial statements of Southwest Airlines Co.
SOUTHWEST AIRLINES CO.
Balance Sheet (partial)
December 31
(in millions)
2004 2003
Total current assets $ 2,172 $ 2,313
Noncurrent assets 9,165 7,565
Total assets $ 11,337 $ 9,878

Current liabilities $ 2,142 $ 1,723
Long-term liabilities 3,671 3,103
Total liabilities 5,813 4,826
Shareholders' equity 5,524 5,052
Total liabilities and shareholders' equity $ 11,337 $ 9,878

Other information:
2004 2003
Net income (loss) $ 313 $ 442
Income tax expense 176 266
Interest expense 88 91
Cash provided by operations 1,157 1,336
Capital expenditures 1,775 1,238
Cash dividends 14 14

Note 8. Leases
The majority of the Company's terminal operations space, as well as 88 aircraft, were under operating leases at December 31, 2004. Future minimum lease payments under non-cancelable operating leases are as follows: 2005, $343,000; 2006, $279,000; 2007, $256,000; 2008, $226,000; 2009, $204,000; after 2009, $1,369,000.
Instructions:
a. Calculate each of the following ratios for 2004 and 2003.
1. Current ratio.
2. Free cash flow.
3. Debt to total assets.
4. Times interest earned ratio.
b. Comment on the trend in ratios.
c. Read the company's note on leases. If the operating leases had instead been accounted for like a purchase, asset and liabilities would increase by approximately $1,500 million. Recalculate the debt to total assets ratio for 2004 in light of this information, and discuss the implications for analysis.

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a. Calculate each of the following ratios for 2004 and 2003.
1 Current ratio.
2 Free cash flow.
3 Debt to total assets.
4 Times interest earned ratio.
b. Comment on the trend in ratios.
c. Read the company's note on leases. If the operating leases had instead been accounted for like a purchase, asset and liabilities would increase by approximately $1,500 million. Recalculate the debt to total assets ratio for 2004 in light of this information, and discuss the implictions for analysis.

CURRENT RATIO= 2004 2003
CURRENT ASSETS/CURRENT ...

Solution Summary

This solution answers various questions pertaining to a company's balance sheet.

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Interpret Southwest Airlines' Balance Sheet

See attached file for clarity.

1. Reading and Interpreting Southwest Airlines' Balance Sheet

The following items appear in the current liabilities section of Southwest Airlines' balance sheet at December 31, 2006.

Air traffic liability $799 million

In addition, one of Southwest Airlines' notes reads as follows: "Tickets sold are initially deferred as air traffic liability. Passenger revenue is recognized when transportation is provided. Air traffic liability primarily represents tickets sold for future travel dates and estimated refunds and exchanges of tickets sold for past travel dates".

Required:

1. What economic event caused Southwest Airlines to incur this liability? Was it an external or internal event?
2. Describe the effect on the accounting equation from the transaction to record the air traffic liability?
3. Assume that one customer purchases a $500 ticket in advance. Determine the effect on the accounting equation from this transaction.
4. What economic event will cause Southwest Airlines to reduce its air traffic liability? Is this an external or internal event?

2. Cash and Accrual Income Statements for a Manufacturer

Drysdale Company was established to manufacture companies for the auto industry. The components are shipped the same day they are purchased. The following events took place during the first year of operations:

a. Issued common stock for a $50,000 cash investment.
b. Purchased delivery truck at the beginning of the year at a cost of $10,000 cash. The truck is expected to last five years and will be worthless at the end of that time.
c. Manufactured and sold 500,000 components the first year. The costs incurred to manufacture the components are (1) $1,000 monthly rent on a facility that included utilities and insurance, (2) $400,000 of raw materials purchased on account ($100,000 is still unpaid as of year-end, but all materials were used in manufacturing), and (3) $190,000 paid in salaries and wages to employees and supervisors.
d. Paid $100,000 to sales and office staff for salaries and wages.
e. Sold all components on account for $2 each. As of year-end, $150,000 is due from customers.

Required:

1. How much revenue will Drysdale recognize under the cash basis and under the accrual basis?
2. Describe how Drysdale should apply the matching principle to recognize expenses.
3. Prepare an income statement under the accrual basis. Ignore income taxes.

3. The Use of Net Income and Cash Flow to Evaluate a Company

After you have gained five years of experience with a large CPA firm, one of your clients, Duke Inc., asks you to take over as chief financial officer for the business. Duke advises its client on the purchase of software products and assists them in installing the programs on their computer systems. Because the business is relatively new (it began servicing clients in January 2008), its accounting records are somewhat limited. In fact, the only statement available is the following income statement for the first year:

Duke Inc.,
Statement of Income
For the Year Ended December 31, 2008

Revenue $1,250,000
Expense $480,000
Salaries and wages 65,000
Supplies 30,000
Utilities 120,000
Rent 345,000
Depreciation 138,000
Total Expense $1,178,000
Net Income $ 72,000

Based on its relatively modest profit margin of 5.76% (net income of $72,000 divided by revenues of $1,250,000) you are concerned about joining the new business. To alleviate your concern the president of the company is able to give you the following additional information.

a. Clients are given 90 days to pay their bills for consulting services provided by Duke. On December 31, 2008, $230,000 of the revenues is yet to be collected in cash.
b. Employees are paid on a monthly basis. Salaries and wages of $480,000 include the December payroll of $40,000, which will be paid on January 5, 2009.
c. The company purchased $100,000 of operating supplies when it began operations in January. The balance of supplies on hand at December 31 amounts to $35,000.
d. Office space is rented in a downtown high-rise building at a monthly cost of $10,000. When the company moved into the office January, it prepaid its rent for the next 18 months beginning January 1, 2008.
e. On January 1, 2008, Duke purchased a computer system and related accessories at a cost of $1,725,000. The estimated useful life of the system is five years.
f. The computer system was purchased by signing a three-year, 8% note payable for $1,725,000 on the date of purchase. The principal amount of the note and interest for the three years are due on January 1, 2011.

Required:

1. Based on the income statement and the additional information given, prepare a statement of cash flows for Duke for 2008. (Simply list all of the cash inflows and outflows that relate to operations).
2. On the basis of the income statement given and the statement of cash flows prepared in (1), do you think it would be a wise decision to join the company as its chief financial officer? Include in your response any additional questions that you believe are appropriate to ask before joining the company.

4. Inventory Turnover for Apple Computer and Hewlett Packard
The following information was summarized from the 2006 annual report of Apple Computers Inc.

(in millions)
____________________________________________________________________________
Cost of sales for the year ended:
September 30, 2006 $13,717
September 24, 2005 (as restated) 9,889
Inventories:
September 30, 2006 270
September 24, 2005 (as restated) 165

Net sales for the year ended:
September 30, 2006 19,315
September 24, 2006 (as restated) 13,931

The following information was summarized from the fiscal year 2006 annual report of Hewlett Packard Company:
(in millions)
____________________________________________________________________________
Cost of sales for the year ended:
October 31, 2006 $55,248
October 31, 2005 52,550
Inventories:
October 31, 2006 7,750
October 31, 2005 6,877

Net revenue for the year ended:
October 31, 2006 91,658
October 31, 2006 86,696

Required

1. Calculate the gross profit ratios for Apple Computer and Hewlett Packard for each of the two years presented.
2. Calculate the inventory turnover ratios for both companies for the most recent year.
3. Which company appears to be performing better? What other information should you consider to determine how these companies are performing in this regard?

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